Can P&G’s CEO Turn This Story Around?

by Susan J. Aluise | May 4, 2012 10:16 am

[1]When you run a massive multinational company with more than $82 billion in annual sales, 26 billion-dollar brands and a market cap of more than $181 billion, you learn to expect tough days. But lately, Procter & Gamble (NYSE:PG[2]) CEO Bob McDonald has had a lot more tough days than easy ones.

The man who has held the tiller at the Dow Jones Industrials component[3] and the world’s largest consumer-products company for the past 33 months is navigating a perfect storm[4]: rising commodity costs, a new frugality among consumers in the U.S. and Europe and price caps on products sold in Venezuela.

Add double-digit gaps in sales and stock price growth compared with rivals such as Colgate Palmolive (NYSE:CL[5]), Kimberly-Clark (NYSE:KMB[6]) and Unilever (NYSE:UN[7]), high-profile fumbles and unexpectedly weak earnings, and McDonald’s “purpose-inspired growth” strategy is wearing thin on Wall Street. And suddenly, the CEO whose enviable product portfolio includes iconic brands such as Tide, Charmin, Crest and Duracell, is on the hot seat.

If you need proof that McDonald’s message is beginning to ring hollow, look no further than P&G’s April 27 earnings report. PG reported that net profit fell 16% in the third quarter, to $2.4 billion (82 cents a share). Although sales increased by nearly 2% during the quarter, to $20.2 billion, P&G cut its full-year earnings forecast to between $3.82 and $3.88 a share. In February the company had forecast net profit of $3.93 to $4.03 a share for the year.

That’s not what McDonald had in mind when he embarked on his purpose-inspired growth strategy, which aimed to manage costs aggressively through downsizing and technology-driven efficiency while investing big in innovation. The goal behind the restructuring plan: to grow global manufacturing capacity, brand value and market share.

But so far, P&G’s progress has not lived up to McDonald’s promise. Global sales growth is flat — advertising increased on core brands, yet market share fell. P&G’s attempt to boost margins by raising prices backfired when competitors held their pricing steady. PG lost what it describes as “significant” market share and now must roll back prices.

Even its attempt to exit the food business by selling the Pringle’s snack-food group had its share of challenges. A deal to sell the group to Diamond Foods (NASDAQ:DMND[8]) for $1.7 billion hit a reef in February after an accounting scandal surfaced at DMND[9]. Fortunately, breakfast cereal giant Kellogg’s (NYSE:K[10]) stepped in to snap up the snack unit for $2.7 billion in cash.

P&G’s restructuring plan has been viewed by many as more disruptive than deliberate. And after the earnings release, the ire of investors and analysts was evident at once: P&G shares fell 3.6% — the stock’s biggest drop since August 2009 — on nearly triple the average daily volume.

Analysts on P&G’s earnings call were openly critical[11] of the company’s strategy and execution; some blamed McDonald directly for the company’s flagging fortunes. In a pointed exchange with McDonald, Citigroup (NYSE:C[12]) analyst Wendy Nicholson dismissed P&G’s “excuses” such as competitors not raising prices, price caps in Venezuela and sluggish developed market sales.

“I’d just say to myself, ‘God, where is the mea culpa taking responsibility for the weak numbers as opposed to saying ‘not our fault, it’s just really tough out there?’” Nicholson said.

“It’s my fault. I am CEO of the company. I do take responsibility,” McDonald responded, adding that instead of impeding P&G’s ability to deliver, the restructuring program would enable it.

But analysts were unwilling to let McDonald off the hook so easily. “How long do you expect investors to wait? How long does your current plan have to work? How much patience does the board have?” Sanford Bernstein analyst Ali Dibadj asked McDonald on the earnings call.

McDonald responded that much of the problem is a lack of innovation in beauty care, a segment that includes Olay, Cover Girl and Dolce & Gabbana fragrances. Sluggish sales in the U.S in particular have stressed the division’s margins and market share.

None of this was what McDonald had in mind when he took over from A.G. Lafley in July 2009. When Lafley stepped into to the top job in 2000, P&G was reeling. Just 18 months earlier, Durk Jager had taken over for John Pepper, one of PG’s most beloved CEOs ever. Jager was billed as the right man to preside over “Organization 2005,” a plan to radically restructure the company so it could compete better globally and double revenues. It didn’t work out that way.

The slash-and-burn Jager spent nearly $2 billion to shake up everything at the company — product launches, testing and marketing. He moved managers around, cut 13% of the company’s global workforce and promised the rapid-fire changes would save P&G nearly $1 billion a year in four years and boost earnings per share by 13% to 15%.

But six months into the plan, analysts and investors began to doubt Jager’s grand vision. “Organization 2005 is more of an evolution than a revolution,” one analyst said in June 1999. “This is a six-year program and investors need to be wary of exactly how long Procter might take to get this business where they want it to be.”

The analysts’ name? Wendy Nicholson, the same inquisitor who took McDonald to task in P&G’s earnings call. Her skepticism in 1999 was well warranted: Just 12 months later, P&G had lost $75 billion in market value, Jager had been run out of Cincinnati on a rail and P&G called Pepper out of retirement to become chairman and named Lafley CEO.

Lafley refocused the company on two key priorities: “The customer is first” and “innovation is everyone’s job.” He was an entrepreneur who ran the massive company with the creative energy of a startup — he worked hard to observe and connect with shoppers. But he also worked hard to find the undiscovered opportunities in consumer products.

As a result, the number of P&G’s billion-dollar brands grew from 10 to 24 during his nine-year tenure and the stock’s market cap more than doubled.

That’s a hard act to follow in the best of times. But the uncharacteristic wrath expressed by analysts last week suggests there may be serious concerns that the Bob McDonald era is headed down the same path as Durk Jager’s. After all, both men prioritized efficiency over innovation, and earnings and margin erosion were early indications that Organization 2005 was headed south.

But for McDonald, a West Point graduate and former captain in the Army’s elite 82nd Airborne Division, retreat is not an option. He first applied to the academy at the age of 11 — and tenaciously kept applying until he was accepted seven years later.

Once McDonald achieved that goal, a line in the famous Cadet’s Prayer became his life motto: “Make us to choose the harder right instead of the easier wrong, and never to be content with a half-truth when the whole truth can be won.”

The bottom line: McDonald’s fight for P&G’s future will not be easy. He has embraced technology and efficiency but has had some big misses in strategy and innovation. And if Wendy Nicholson sees this CEO’s future as clearly as she saw Jager’s, McDonald may be on borrowed time.

While it’s easy to recognize that your products are priced higher than those of your competitors, it’s much harder to do something about it. While the temptation is simply to lower prices, Lafley succeeded by using innovative advances to differentiate P&G’s products. By incorporating additional value into premium products, he changed the game. Rising commodity costs make it even more important to compete by giving consumers a higher value proposition.

McDonald has put in place plans to effect half of the solution: His advanced technologies and supply-chain improvements will yield cost efficiencies and boost productivity. But if P&G is to reclaim its market share and margins, McDonald must embrace the “whole truth” — by increasing his focus on innovation. Time will tell if McDonald can succeed in choosing the “harder right.” If he can, P&G and its investors will be better for it.

As of this writing, Susan J, Aluise did not hold a position in any of the stocks named here.